Capital Infusion: Private Equity Update 1MAY 2013This newsletter provides onlygeneral information and shou... Capital Infusion: Private Equity Update 2The provider’s payer mix often guides regulatorycounsel’s review ... Capital Infusion: Private Equity Update 3business in the past because it has been offeringinducements that... Capital Infusion: Private Equity Update 4to require a new application on the level of corporateownership a... Capital Infusion: Private Equity Update 5Number offull-timeemployeesrepresentations about compliance with ... Capital Infusion: Private Equity Update 6would be 45 + (2200/120), or 63.3. Because theemployer’s number o... Capital Infusion: Private Equity Update 7parent/subsidiary relationship – to the extent that anyprivate in... Capital Infusion: Private Equity Update 8For a more detailed analysis of the ACA, including adiscussion of... Capital Infusion: Private Equity Update 9At first glance, the scenarios described above wouldlikely seem g... Capital Infusion: Private Equity Update 10If a down-round equity financing is completed, andthe company is... Capital Infusion: Private Equity Update 11positioned to argue that a thorough evaluation anddecision-makin... Capital Infusion: Private Equity Update 12whether undertaken by financial advisors orotherwise), the actio... Capital Infusion: Private Equity Update 13this reality, offering companies the ability to loweremployee co... Capital Infusion: Private Equity Update 14Capital Infusion: What other significant challenges are outsourc... Capital Infusion: Private Equity Update 15all of those who were involved in pushing itsuccessfully across ... Capital Infusion: Private Equity Update 16warrant as a partnership interest is likely to depend onthe appl... Capital Infusion: Private Equity Update 17exempt entities? If the warrant holder is acorporation, does it ... Capital Infusion: Private Equity Update 18INCOME PRODUCING PARTNERSHIPFAVORABLE FACTORS UNFAVORABLE FACTOR... Capital Infusion: Private Equity Update 19FAVORABLE FACTORS UNFAVORABLE FACTORSPartnership orLLC HoldingWa... Capital Infusion: Private Equity Update 20Note that the present value test requires a stronglikelihood of ... Capital Infusion: Private Equity Update 21be strictly relied upon when making a determination asto whether... Capital Infusion: Private Equity Update 22the invention was directly or indirectly disclosedwithin one yea... Capital Infusion: Private Equity Update 23covered topics including Medicaid expansion, healthinsurance exc... Capital Infusion: Private Equity Update 24PATTON BOGGS DEALSOur expertise and experience in private equity... Capital Infusion: Private Equity Update 25ORIX PRIVATE EQUITYTHE MEADOWS, A PORTFOLIOCOMPANY OF AMERICAN C... Capital Infusion: Private Equity Update 26For more information, contact your Patton Boggs LLP attorney, th...
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Capital Infusion: Private Equity Update

  1. 1. Capital Infusion: Private Equity Update 1MAY 2013This newsletter provides onlygeneral information and shouldnot be relied upon as legal advice.This newsletter may be consideredattorney advertising under courtand bar rules in certainjurisdictions.IN THIS ISSUEDigging Deeper: A Guide toHealth Care Regulatory DueDiligence in Private EquityDeals 1Policy Spotlight: AffordableCare Act 5Case Spotlight 8Dealmaker’s Corner 12Deal Spotlight 14Tax Consequences:Noncompensatory PartnershipOptions 15A New Day for Patents 21Event Spotlight: Health CareSeminar 22Patton Boggs Deals 24CAPITAL INFUSION:PRIVATE EQUITY UPDATEDIGGING DEEPER: A GUIDE TO HEALTHCARE REGULATORY DUE DILIGENCE INPRIVATE EQUITY DEALSBy Amy Kaufman and David McLeanINTRODUCTIONInvesting in the health care industry can be riskier and more complicated thaninvesting in many other industries. Health care providers and suppliers, as well asthose companies that interact with them, operate in an intense regulatoryenvironment and are the subject of increased government scrutiny for fraud andabuse and other matters related to compliance. Therefore, any unsuspectinginvestor that makes a wrong move during the investigative stages of a transactioncan find itself in deep water after closing. An investor that seeks regulatorycounsel to guide it through the transaction, however, can be in a better position tomake informed business decisions. This article highlights key areas in which aninvestor can expect regulatory counsel to focus its efforts and some of the issuesthat an investor can expect to encounter along the way.ASSESSING RISKS AND LIABILITIESDuring the due diligence phase of a health care transaction, regulatory counsel willclosely examine the target provider’s past and current practices to assess the risksand liabilities an investor could face if the transaction closes. Counsel shouldpresent a thorough diligence request list to the seller for items such as commercialpayer contracts, documentation of enrollment with Federal health care programs,contracts with physician referral sources, lists of referral sources, real property andequipment leases, licenses, audits, information about litigation and governmentinvestigations, a summary of any Health Insurance Portability and AccountabilityAct (“HIPAA”) breaches and enforcement actions, and information about theprovider’s internal compliance program.
  2. 2. Capital Infusion: Private Equity Update 2The provider’s payer mix often guides regulatorycounsel’s review of documents because of its relationto the laws the provider must follow and the severityof the consequences that can result from a violation.Liabilities can be particularly significant when aprovider enrolled in Medicare, Medicaid, or TRICAREviolates the Stark Law and Anti-Kickback statute.Therefore, regulatory counsel often will focus part ofthe review in these areas if the target provider isenrolled in one of those Federal health care programs.While this article focuses on those two laws, theviolation of other Federal and state laws can createsignificant liabilities as well.The Stark Law prohibits physicians from referringMedicare and Medicaid patients for certain designatedhealth services (“DHS”) to an entity with which thephysician or an immediate family member of thephysician has a financial relationship, unless anexception applies. The Anti-Kickback statute is acriminal statute that prohibits the exchange (or offerto exchange) of anything of value in an effort toinduce or reward the referral of Federal health carebusiness. To evaluate the provider’s compliance withthese laws, regulatory counsel should analyze theprovider’s financial relationships with physicianreferral sources, as well as the incentives orinducements that the provider offers or provides topatients in order to generate business. The term“financial relationships” is interpreted broadly and canencompass relationships ranging from employment,professional services, or recruitment agreementsbetween the provider and a physician, to equipment orlease agreements between the provider and an entity inwhich an immediate family member of a physician hasan ownership interest.The penalties associated with a violation of these lawscan potentially be damaging to a provider. A violationof the Stark Law can result in denial of payment,mandatory refunds of reimbursement money, civilmonetary penalties, and/or exclusion from the Federalhealth care programs. A violation of the Anti-Kickback statute can result in a criminal conviction,civil monetary penalties (which could result in trebledamages plus $50,000 per violation), and/or exclusionfrom the Federal health care programs. Notably, thisrisk is now present more than ever because of thegovernment’s increased interest in enforcement inthese areas. As such, an investor should determine if itwants a provider to resolve any actual violations priorto closing, either by making a repayment for moniesowed or by voluntarily disclosing a violation to thegovernment and reaching a settlement agreement,thereby reducing the risk that a new owner will carrythis type of liability going forward.An investor must also consider what impact theseviolations might have on the provider’s future revenuestream, one of the most important aspects of a buyouttransaction involving leveraged financing. It might bethat a provider has been so successful in generatingA provider’s compliance with the Stark Law and Anti-Kickback statute should matter to investors for threekey reasons:→ the penalties associated with violations,→ the impact on future revenue streams, and→ the effect on purchase price.
  3. 3. Capital Infusion: Private Equity Update 3business in the past because it has been offeringinducements that violate the Anti-Kickback statute.Even if the investor is able to account for pastliabilities, it should be aware that the provider willhave to change its practices immediately and shouldevaluate whether the provider will be able to generatesufficient revenue after closing. If not, the investmentmight no longer be attractive, or worse, the buyermight not be in a position to service its debt payments.Finally, an investor should consider what effect, if any,these liabilities and changes in future practices have onthe price it wants to pay to invest in the business. Thisdovetails with the discussion above related to futurecash flows. While a dramatic impact to the cash flowsmay impact whether an investor wants to proceed witha transaction, it may be the case that an adjustment tothe purchase price can be negotiated that will stillcause the investment to be attractive to the investor.NOTIFYING THE GOVERNMENTRegulatory counsel will determine the types ofgovernment notifications and/or consents that arerequired in connection with the transaction as part ofits due diligence review. This determination involves aclose examination of the types of enrollments, statelicenses, certificates of need, and accreditation, amongother items, that a particular provider has on file.1 Aninvestor should pay close attention to this process forthree key reasons:→ government notification requirements couldimpact the way in which an investor shouldconsider structuring the transaction;1 This scope of this review will vary by provider type.→ such notifications could have an impact on theprovider’s ability to operate or bill a Federal payerfor its services for a set period of time afterclosing; and→ such notifications could impact the timing of theclosing date.At the beginning of the diligence process, regulatorycounsel should work with corporate and tax counseland the investor to determine the most appropriateway to structure the transaction.2If a provider transfers ownership as part of a stockpurchase, however, CMS might treat the transaction asa “change of information,” rather than a “change ofownership” (commonly referred to as a “CHOW”),and not require the provider to submit a newapplication. The same could be true for Medicaid,depending upon the state and the type of providerinvolved. Moreover, state licensing boards mightrequire new licensure applications in connection with atransaction; however, a board might base its decision2 It is important to confirm that this general rule applies tothe particular provider type involved in this transaction.While the investor should take into account potentialliabilities and the tax planning efforts of the partieswhen it considers whether an asset purchase or stockpurchase is preferable, as stated above, governmentnotifications also matter. For instance, the Centers forMedicare and Medicaid Services (“CMS”) oftenrequire providers that transfer ownership as part of anasset purchase to apply for a new Medicare number.
  4. 4. Capital Infusion: Private Equity Update 4to require a new application on the level of corporateownership affected by the transaction rather than onthe type of transfer (asset vs. stock) that takes place.In the event the chosen transaction structure triggerscertain government notifications and/or newapplications, the investor should be aware of theimpact this decision could have on the provider’sability to bill a Federal payer for its services or operateafter closing. It should also be aware that rules andexceptions to the rules in these areas will vary by state.In the Medicaid context, for example, a providermight be required to hold claims until an applicationfor a new enrollment number is approved. This couldresult in a short-term depletion of the provider’srevenue stream. In the licensure context, a providermight not be able to operate until its application for anew type of license is approved. Sometimes thisinterruption in service can be avoided by submittingnew applications a significant amount of time prior toclosing or by entering into a management agreementwith the previous owner after closing, which can allowthe new owner to operate under the old owner’slicense until the new one is approved. If any of theseissues are of significant concern to the investor, itshould consider structuring the transaction to mitigatethe impact of these requirements.The investor should also be aware that a governmentnotification requirement can impact when atransaction will be able to close. Often a buyer mustprovide agencies with advanced notice of a transactionor obtain certain approvals before a transaction canoccur. Therefore, an investor might not be able tomove forward as quickly as it expected or planned. Toavoid any confusion or surprises, however, regulatorycounsel, the investor, and the provider should have aconversation about timing as early in the diligenceprocess as possible.By nature, a private equity investor desires to maintainthe confidentiality of its own ownership structure,including the financial and personal information of itsinvestors. Unfortunately, in the world of governmentnotifications in health care transactions, maintainingsuch confidentiality is a challenge. Governmentagencies such as CMS, State Medicaid agencies,licensing boards, pharmacy boards, and others mightrequire buyers to disclose direct and indirect owners(in some cases those with as little as a five percentownership interest), as well as other principals, of theprovider (after giving effect to the new ownership) inconnection with required notifications and/or newapplications. Therefore, while the rules vary by agency,an investor should not be surprised if the governmentrequests this type of information, and shouldundertake to commence the diligence process as soonas possible in order to assess the approvals andnotifications that might be required in connection withthe transaction.THE PURCHASE AGREEMENT AS THE “CATCH-ALL”In an ideal world, regulatory counsel will learn aboutevery aspect of a provider’s business during the duediligence process. In reality, however, regulatorycounsel will be dealing with imperfect information andwill have the chance to review only the documentsthat the seller is willing to provide. The purchaseagreement serves as one means for counsel and theinvestor to try to level the playing field with the seller.As such, regardless of how the transaction isstructured, the purchase agreement should require theseller to make detailed and far-reaching
  5. 5. Capital Infusion: Private Equity Update 5Number offull-timeemployeesrepresentations about compliance with health carelaws. Additionally, the purchase agreement shouldhold the seller accountable for making any falsestatements relating to those representations and forany health care liabilities that regulatory counsel wasunable to identify during due diligence in order to bestensure that the investor will have adequate recourseagainst the seller if any liabilities or “surprises” cometo light after closing.CONCLUSIONWhile health care deals can be intimidating tounfamiliar investors and often involve unexpecteddevelopments along the way, the process can besmooth if the investor learns to expect anything. Bystaying in front of the issues that are bound to arise,regulatory counsel can be in a position to timely andsuccessfully navigate the investor through theregulatory minefield and successfully close on a timelybasis, while at the same time reducing risk for theinvestor.POLICY SPOTLIGHT:AFFORDABLE CARE ACTEMPLOYER RESPONSIBILITIES UNDER THEAFFORDABLE CARE ACT AND THE IMPACTON PRIVATE INVESTMENT FUNDSImplementation of the Affordable Care Act (“ACA”)continues at an accelerated pace. Some of its mostimportant provisions for employers are scheduled totake effect in January 2014. With the force of theseprovisions now less than a year away, employers needto understand their impact and begin to prepare nowto comply with the new requirements. The articlefocuses on one particular aspect of the ACA’s auditimplication on private investment funds.In deciding whether to offer health insurance coverageto its employees, an employer must determine whetherit is subject to the penalties imposed by ACA’semployer responsibility provisions. If subject to thepenalties, the employer should calculate (i) the penaltyit could face if it chooses not to offer coverage, ascompared to (ii) the cost of offering health coverage toemployees, discounted by the value generated byproviding the coverage in the form of its wage effectsand its impact on employee health and satisfaction.The ACA imposes penalties only on employers with50 or more full-time equivalent employees. Tocalculate full-time equivalent employees, employersmust use the following formula:If this sum is equal to 50 or greater, a company will besubject to penalties if both (i) it does not offer healthcoverage AND (ii) any one of its full-time employeesreceives a federal premium tax credit to purchasecoverage on an exchange. For example, for anemployer with 45 full-time employees, and 20 part-time employees, each of whom works 110 hours permonth, the number of full-time equivalent employeesSum of the hours workedby each part-timeemployee in a month (upto 120 hours/employee)120+
  6. 6. Capital Infusion: Private Equity Update 6would be 45 + (2200/120), or 63.3. Because theemployer’s number of full-time equivalents exceeds50, the employer would be an applicable largeemployer and would face penalties if any of its full-time employees receives a federal premium tax credit,even though it employs fewer than 50 full-timeemployees.In calculating your number of full-time equivalentemployees, be aware that the sum must include theemployees of all entities in a “controlled group,” asdefined by Internal Revenue Code section 414. Yourcompany may, therefore, be considered a largeemployer based on not only your employees but alsothe employees of your related entities. Section 414defines controlled groups based on three types ofrelationships:→ A controlled group exists based on a parent-subsidiary relationship when a parent organizationowns 80 percent or more of the equity in asubsidiary. If your company owns 80 percent ormore of the equity in another company, thatcompany’s employees will count toward yournumber of full-time equivalent employees for thepurposes of determining large employer status.Further, if that subsidiary owns 80 percent ormore of the equity in another company orcompanies, those companies’ employees must alsobe included within your controlled group.→ A controlled group exists based on a brother-sisterrelationship when the same five or fewer people,who must be individuals, trusts, or estates,together own at least 80 percent of the equity ineach of two organizations and at least 50 percentof the ownership of the organizations is identical.For instance, three individuals, A, B, and C, mightown stock in two companies, Y and Z. Y and Zare members of a controlled group if A, B, and Ccollectively own 80 percent of each company andat least 50 percent of the ownership of thecompanies is identical. If A owns 20 percent of Yand five percent of Z, B owns 10 percent of Y and20 percent of Z, and C owns 50 percent of Y and60 percent of Z, Y and Z are members of acontrolled group. A, B, and C collectively own 80percent of Y and 85 percent of Z. Additionally, 65percent of the ownership of Y and Z are identical– A’s five percent interest in Z is mirrored in Y,B’s 10 percent interest in Y is mirrored in Z, andC’s 50 percent interest in Y is mirrored in Z. If,however, B and C’s ownership interests aredifferent, such that B owns 10 percent of Y and60 percent of Z and C owns 50 percent of Y and20 percent of Z, Y and Z would not be membersof a controlled group. Though A, B, and C wouldstill collectively own 80 percent of both Y and Z,there would be only 35 percent identicalownership between the two companies.→ A controlled group also exists in the case of an“affiliated service group,” where several serviceorganizations regularly collaborate in the servicesthey provide and are linked by at least 10 percentcross-ownership.HOW DO THE “CONTROLLED GROUP” TESTSIMPACT PRIVATE INVESTMENT FUNDS?This “controlled group” analysis is especially criticalwhen examining whether private investment funds andtheir individual portfolio company investments aresubject to the penalties imposed by ACA. Based onthe first of the above described relationship tests – the
  7. 7. Capital Infusion: Private Equity Update 7parent/subsidiary relationship – to the extent that anyprivate investment fund owns at least 80 percent ofthe equity in a portfolio company, that privateinvestment fund will technically be aggregated withthat portfolio company as part of a controlled groupand prospectively subject to the penalties imposed byACA. However, private investment funds themselves(whether formed as limited partnerships, limitedliability companies, offshore corporations orotherwise) generally do not actually have employeessince they are only pools of capital, and those whomanage (i.e., “work for”) a private investment fund areemployed by the fund’s sponsor and/or investmentmanager, which is a separate entity that does not,itself, have an ownership interest in the portfoliocompany under normal circumstances. Accordingly, tothe extent a portfolio company has 50 or more full-time employees and a private investment fund with noemployees owns at least 80 percent of the equity ofthat portfolio company, the private investment fundwould be considered a large employer under theparent/subsidiary relationship test, but is not likely tobe subject to penalties under ACA (the result may bedifferent, however, in the rare case of a privateinvestment fund that actually has employees).Nonetheless, there may be other consequences to aprivate investment fund that would impact its bottomline from an economic standpoint. For example, if anyof its portfolio companies acquired other companies,the same controlled group analysis using theparent/subsidiary relationship test would be applied inconnection with those acquisitions. As a result, aprivate investment fund could be aggregated with thesubsidiaries of its portfolio companies if the 80percent equity ownership threshold is met in relationto the acquired subsidiaries. Any penalties imposed onthe portfolio companies and their subsidiaries underACA could, therefore, have a negative impact on theprivate investment fund’s returns.Another important consideration occurs in the case ofmany different portfolio companies that arecommonly owned by a single investment fund andwhether these different portfolio companies would beaggregated to create a controlled group. In this case,the brother-sister relationship test may be applicable,depending on the ultimate ownership of the fund. Therequirement for the brother-sister test is that thecommon owners must be individuals, trusts or estatesand that the same five or fewer people own at least 80percent of each organization (with at least 50 percentownership being identical). The only way to triggerthis test in the investment fund context would requirea “look through” to the ultimate ownership of theinvestment fund. The rules are not abundantly clear indescribing circumstances as to when such a look-through would be imposed. To the extent that such alook-through were indeed prescribed, the nature andcharacter of the investment fund’s investors wouldneed to be carefully examined. Accordingly, a privateinvestment fund having an ownership structure thatlines up with the test imposed by the brother-sistertest (i.e., five or fewer individuals, trusts or estatesholding greater than 80 percent of the investmentfund with at least 50 percent ownership beingidentical) should carefully analyze this rule with itslegal counsel.
  8. 8. Capital Infusion: Private Equity Update 8For a more detailed analysis of the ACA, including adiscussion of required coverage amounts, penaltycalculations, eligible employees and tax implications,please see the Patton Boggs Client Alert dated March26, 2013. That Alert can be found here.CASE SPOTLIGHTDOWN-ROUND EQUITY FINANCINGS ANDSUBSEQUENT EXIT TRANSACTIONS - BESTPRACTICES FOR PREFERRED INVESTORSAND THEIR BOARD DESIGNEESBy Akash Sethi and Ryan MitchellToday’s middle market private equity landscape is asdiverse and varied as it has ever been. With newportfolio investments scattered across a multitude ofvarying industries, it is clear that investor confidencehas improved dramatically since the onset of the GreatRecession. Yet, despite the general renewedconfidence among private equity investors, one thinghas and will continue to remain the same – not allequity investments are wildly successful (at least forsome classes of shareholders).Those who have been involved in the private equityspace for any period of time are likely familiar with“down-round” equity financings and their impact onsubsequent exit transactions. A down-round equityfinancing transaction is one where the target companyhas a “pre-money” valuation that is lower than the“post-money” valuation following its most recentlycompleted round of financing. In other words, thetarget company has a lower valuation now than it didat the time of the most recently completed financing,such that the securities purchased in the current roundare effectively “cheaper” based upon the lowervaluation. Such down-round equity financings oftenserve to substantially dilute the equity positions ofprior investors, as well as grant substantialmanagement and economic rights to the investors whoparticipate. Among other things, the end result is oftenthat the down-round investors receive significantboard representation in addition to substantialliquidation preferences (often 2.0-3.0x or more) ontheir invested capital, which reduces the expectedreturns of non-participating shareholders. As a result,down-round financings can result in preferredinvestors taking management control of a companythat enables them to drive an exit transaction wherethe company is sold at or below the liquidation valueof the preferred equity issued in the down-round.Consequently, preferred investors experience apositive return, while the holders of junior equitysecurities receive very little or no proceeds from a sale,barring a substantial turnaround of the company andthe opportunity to sell for an optimistic (and oftenunrealistic) premium.Alternatively, the typical private investment fund thathas an investor base consisting of several public andprivate pensions and other institutional investorsshould not be captured by the brother-sisterrelationship test. Given the critical nature of this issue,however, it is highly recommended that all privateinvestment funds consult with legal counsel in order toanalyze the application of this rule to their uniquecircumstances.
  9. 9. Capital Infusion: Private Equity Update 9At first glance, the scenarios described above wouldlikely seem grossly unfair to the common shareholders(who often include, at least in part, the individuals whoinitially founded the company); however, down-roundfinancings often provide a critical capital injection intoa company, without which it would not survive, andthese “last dollars in / first dollars out” (or “LIFO”)arrangements are typical constructs in mostinvestment transactions. The necessity for suchfinancings may be the result of poor management bythe founders, general economic deterioration orotherwise. In any event, the investors in a down-roundfinancing are taking on substantial risk by committingcapital to a distressed entity, and therefore expect ahigh rate of return, hence the aforementionedliquidation preferences that are commonplace.Preferred investors and their board representativesshould be well versed with respect to the fiduciaryduties that directors owe to the company and itsshareholders, or risk finding themselves in a situationsimilar to directors in the recent Delaware case ofCarsanaro v. Bloodhound Technologies3, which serves as ableak reminder of what not to do in cases of down-round financings and exit transactions. While differentstates impose varying duties on directors, the majorityof an investment fund’s portfolio companies are oftengoverned by Delaware law, which is the focus of thisarticle. Under Delaware law, a director is bound by thefollowing duties of loyalty, care and disclosure:3 Carsanaro v. Bloodhound Technologies Inc., Del. Ch., C.A. No.7301-VCL, 3/15/13.The duty of loyalty requires that directors act in goodfaith and in the honest belief that a particulartransaction is in the best interests of the company andits shareholders. Among other things, this dutyrequires a subordination of personal interests to theinterests of the company and its shareholders.The duty of care requires that directors exercise care inthe performance of their responsibilities, meaning thatsuch directors make a reasonable effort to considerand evaluate all material information when makingdecisions in their capacity as directors.The duty of disclosure requires directors, whenseeking shareholder action, to disclose to shareholdersall material facts that are relevant to the action forwhich the directors are seeking shareholder approval.In the event a director fails to comply with thesefiduciary duties when taking a particular action, theaction taken can be subject to invalidation and thedirector may face personal liability for theconsequences of the action taken.Of particular importance to private investment fundsmaking preferred investments in portfolio companies,the Delaware Court of Chancery has held that directorsowe these fiduciary duties to both preferred andcommon shareholders, but where a right claimed bypreferred shareholders is a preference against thecommon stock, it will generally be a director’s duty toprefer the interests of common stock to the interestsof the preferred stock, where a conflict exists.Certainly, this may come as a surprise to some.
  10. 10. Capital Infusion: Private Equity Update 10If a down-round equity financing is completed, andthe company is ultimately successful thereafter, anyshareholders that did not participate in the down-round may very well allege that the approval of thedown-round transaction was tainted by theinvolvement of “interested directors” who breachedtheir fiduciary duties to the company’s existingshareholders by authorizing the transaction.Generally, director decisions are shielded by the“business judgment rule,” which is a presumption thatdirectors acted on an informed basis, in good faith andin the honest belief that the action taken was in thebest interest of the company. However, the businessjudgment rule is not applicable in interested directortransactions. In the case of such interested directortransactions, the interested directors bear the burdenof establishing the “entire fairness” of the transaction.Typically, an interested director transaction is one inwhich (i) certain directors have a material financialinterest in the transaction that is not shared by thecompany and its shareholders and (ii) the materiallyself-interested directors: (a) constitute a majority of theboard, (b) control and dominate the board as a whole,or (c) fail to disclose their interests in the transactionwhere a reasonable board member would haveregarded the existence of their material interests as asignificant fact in the evaluation of the proposedtransaction.So what are preferred investors and their boarddesignees to do? While there is never a guarantee thata given action will be fully-insulated from ashareholder challenge with respect to the entirefairness standard, the list below sets forth somerecommended steps that should be considered inconnection with evaluating and approving, asapplicable, any down-round financing or sale of thecompany at or below the preferred liquidationpreference:→ Ensure that there are no more attractivealternatives available. This should involve athorough canvassing of the market to determinewhat alternatives are available, with the board’sfindings to be thoroughly documented andincluded in the minutes of the board meetings.→ Have multiple board meetings to evaluateavailable alternatives and make decisions,including specific discussions regarding the impacton junior equity classes. By holding multiple, well-documented meetings the board will be betterTo prove the entire fairness of a transaction, one mustshow the existence of fair dealing as well as fair price.With respect to the fair dealing component, thisinvolves an analysis of procedural matters such ashow the transaction was timed, structured andnegotiated, and how the approvals of the requisitedirectors and shareholders were obtained (includingwhether adequate disclosures were made inconnection with it). With respect to the fair pricecomponent, a court will determine fair price as anamount that is within a range that a reasonable personwith access to relevant information might accept.
  11. 11. Capital Infusion: Private Equity Update 11positioned to argue that a thorough evaluation anddecision-making process was undertaken.Additionally, the earlier the evaluation process canbegin, the better, as the company is more likely tohave a greater number of alternatives (with betterterms) to choose from if a proper amount of timeis allotted to the process.→ Offer minority shareholders the right toparticipate in the down-round on a pro rata basis.By offering all shareholders the right toparticipate, the investor(s) leading the down-roundwill be viewed more favorably (and less like thebully on the block that is intentionally washing outthe minority positions of others). Moreover, itbecomes more difficult for a minority shareholderto argue that a fair price was not obtained whensuch shareholder, in fact, rejected that price.→ Appoint a special committee of disinteresteddirectors to evaluate the transaction. A court willbe less likely to find that a director actedimproperly in approving a particular action if suchapproval was based on an unbiasedrecommendation from a bona fide specialcommittee that was appointed to independentlyevaluate the transaction.→ Obtain a fairness opinion or an independentappraisal from an investment bank or independentadvisor to support the valuation of the companyupon which the transaction is based.→ Provide for a nominal “carve-out” for commonshareholders in connection with sale transactionsat or below the preferred liquidation value, suchthat the common shareholders receive at leastsome proceeds from the sale.→ Include a well-crafted drag-along provision inshareholder agreements. While not necessarilydeterminative, the presence of a drag-alongprovision can arguably serve as a good fact for theinvestor(s) leading a sale transaction. To the extenta sale transaction is being effectuated by usingsuch a drag-along provision, ensure that theparties entitled to exercise the drag-along rightcomply strictly with its requirements.→ Use discretion when taking actions that, whilecontractually permitted, may be viewed withdisfavor by a court. For example, a preferredinvestor may have a broad contractual right toamend the portfolio company’soperating/governance documents, including theability to eliminate notice requirements or similarrights otherwise provided to holders of juniorclasses of equity. Unless absolutely necessary toconsummate a particular transaction, such actionsshould be avoided as they may trigger an increasedlevel of judicial scrutiny.→ Attempt to secure a disinterested third party tolead any down-round financing. It will be muchmore difficult to argue that a director wasbreaching his or her duty of loyalty to thecompany and its shareholders if the transaction isnegotiated at arms’ length with an unaffiliatedthird party.→ Solicit the approval of the disinterestedshareholders and distribute robust informationstatements to all shareholders with respect to thecontemplated transaction, including unambiguousexplanations of the anticipated effect on all classesof equity interests.→ Document, document, document! It is absolutelycritical to maintain detailed records setting forththe alternatives considered (including all effortsmade to locate prospective investors/purchasers,
  12. 12. Capital Infusion: Private Equity Update 12whether undertaken by financial advisors orotherwise), the actions taken and the underlyingrationale for them.In summary, down-round financings (as well assubsequent exit transactions that result in most or allof the sale proceeds being allocated to preferredinvestors) are not uncommon, and carry with them therisk that a class of junior equityholders may bring achallenge. Practically speaking, it would be rare for allof the above recommended actions to be taken inconnection with a particular transaction, given theassociated time and expense (and in some cases,futility). For any number of reasons, certain of theseactions may or may not be feasible or desirable in agiven scenario. Nevertheless, preferred investors andtheir board designees should endeavor to employ asmany of these strategies as are practicable in a givensituation, or risk greater exposure to shareholderlitigation and increased judicial scrutiny.DEALMAKER’S CORNERIn this issue’s installment of “Dealmaker’s Corner,”Jon Finger, a partner in our private equity group, hadthe opportunity to visit with Kyle Bradford, ManagingDirector with American Capital, Ltd., concerning thepharmaceutical services industry.Capital Infusion: What are the significant benefits ofoutsourcing services in the pharmaceutical industry?Kyle: There are many benefits and I think you will seeoutsourcing continuing to build on its growth that hasbeen going on for years. Two of the main benefits thatpharmaceutical companies realize are a reduction offixed costs and more cost flexibility. This helpscompanies maintain margins and increase profitability,which has become increasingly important over theyears as the pharmaceutical industry has evolved andbecome more competitive with the advent of the smallbiotech and midsize pharmaceutical manufacturersthat operate, in many instances, a fully outsourcedmodel. In the 1990’s and the early 2000’s, there werevery large blockbuster drugs driving an incredibleamount of growth for pharma companies and many ofthose drugs have seen patent protection expirerecently. The loss of these big “cash cows” with arelative slowing of development of new blockbusterdrugs has contributed to the rise in outsourcing. Inaddition, novel new compounds are becoming morecomplex and more targeted, focusing on smallerpopulations. This trend will only continue, andspecialized Contract Development and ManufacturingOrganizations (“CDMOs”) are in a unique position tocapture increased share as they have the technicalcapabilities to develop complex and uniquecompounds.Capital Infusion: In what other ways do service providers helpcompanies in the pharmaceutical industry?Kyle: As drugs become increasingly more complexand targeted, pharma companies cannot oftenrationalize having all of the necessary technology “in-house,” and so they look to the providers who havevaried technologies available for instant utilization.Also, in today’s environment with increased scrutinyby the Food and Drug Administration (“FDA”), thecost and timeframe of getting drugs to market hasincreased substantially. Outsourcing has allowedpharma companies to become more nimble to address
  13. 13. Capital Infusion: Private Equity Update 13this reality, offering companies the ability to loweremployee count and become more virtual and flexible.Capital Infusion: How have you seen the pharma servicesindustry evolve over the years?Kyle: It was probably 20 years ago when you reallystarted seeing the industry take off and we’ve seen itplay out on chemical entities or small molecule drugs.Today, I suspect more than half of all clinical trials, aswell as greater than half of the manufacturing of smallmolecule drugs, are now being outsourced. I contrastthis with the biologic space, where a much smallerpercentage of the manufacturing is being outsourcedright now. However, you are starting to see morespecialized, biologic-focused CDMOs and so, over thenext decade, I think you will see the percentage ofbiologic CDMO demand grow like we have seen inthe chemical space.Capital Infusion: How did the recent recession affect theoutsourcing industry?Kyle: The recession definitely affected the industry,particularly on pre-clinical R&D spending, where wewitnessed a pretty significant drop in pre-clinical R&Dspending after the recession. Pharma companiesstarted really focusing their R&D dollars on later stageproducts and so the earlier stage R&D got hit hard.That decline seems to have bottomed and I wouldexpect that segment to start coming back over thenext 5 years or so. Obviously, drug development is notgoing to go away, and so people are eventually goingto have to start reinvesting in the earlier stagemolecules to get them in the pipeline and in clinicaltrials. Right now, pharma companies seem focused ondrugs that are further along and closer tocommercialization; trying to get them out to market inorder to start realizing returns.Capital Infusion: Have you seen service providers moving moretoward specialty areas as opposed to trying to be more ofgeneralists?Kyle: I think that really varies by provider. You havethe larger players who are able to be larger and moregeneralists. They are acquisitive and buying smallercompanies that are specializing in order to acquirecertain capabilities instead of developing them. Wecertainly see smaller players that are popping up andfocused on areas such as genomics, proteomics andcombinatorial chemistry.Capital Infusion: One of the most significant issues facing thewhole health care industry is the implementation of“Obamacare.” How do you think outsourcing has beenimpacted by this legislation?Kyle: As with the entire industry, it is the overalluncertainty that also leads to more conservativebehavior from pharma companies, which causes lowerspending on R&D and obviously impacts theoutsourcing market. With greater clarity, you shouldsee further improvement in R&D spending.As they build this expertise, you will see larger playerscoming in and making acquisitions to further diversifytheir offerings to the industry. I expect to see moreconsolidation taking place, driven by other dynamicsas well such as credit availability, cash on the balancesheet, and increasing market levels and confidence.
  14. 14. Capital Infusion: Private Equity Update 14Capital Infusion: What other significant challenges are outsourceproviders facing today?Kyle: Competition, and in particular, Asiancompetition, has been a significant challenge and itcertainly depends on where you are focused. Whileinternational low-cost competition is present,anecdotally, we are starting to see projects return tothe U.S. as a result of better quality, a creep up inprices overseas and IP leakage. Outsource providersalso continue to need to be aware of andaccommodate the increased FDA scrutiny thatimpacts all the players in the market. Collocation inNorth America and Europe, the centers of drugdevelopment, is very important in the developmentprocess, especially for small and mid-sized specialtypharma and biotech.DEAL SPOTLIGHTPATTON BOGGS ADVISES ON INNOVATIVEHEALTH CARE TRANSACTIONPatton Boggs recently advised Satori Capital, a Dallas-based private equity firm, on its acquisition ofLonghorn Health Solutions, Inc. Longhorn isheadquartered in Austin, Texas and is a leading direct-to-home provider of consumable medical supplies anddurable medical equipment. Longhorn also recentlylaunched a pharmaceutical division that serves theentire state of Texas. Longhorn employs a uniquebusiness model in which it brings its medical productsdirectly to the homes of Medicare, Medicaid andprivately insured patients utilizing vans dispatchedfrom its warehouses located throughout Texas, amodel that has been called the “future” of patientprovided health care.While financial terms of the transaction were notannounced, Longhorn’s founder and Chief ExecutiveOfficer Britt Peterson maintained an ownershipposition in the company and will continue as its CEO.The transaction was particularly notable for thecomplex health care regulatory hurdles that had to beovercome and addressed in order to maintaincontinuity of Medicare and Medicaid provider status,as well as preserve the company’s competitive biddingarrangements and other aspects of its business andoperations.The Patton Boggs attorneys advising on thetransaction worked closely across several differentpractice groups, including private equity and corporatefinance, health care, public policy and tax, to achievethe most efficient and beneficial outcome for theoverall transaction – taking both its client’s, as well asthe seller’s, interests into account. The transaction wasparticularly challenging given the short time framesurrounding a closing at the end of December. Inaddition to the looming fiscal cliff which wasmotivating buyers and sellers across all industries tourgently close transactions and putting a strain onresources of financiers, lenders and investors, the year-end holiday season is always a difficult environment tocoordinate the necessary Federal and state regulatorynotices, licensing and approvals that are involved inthe acquisition of a health care service provider suchas Longhorn.The closing of the Longhorn transaction was atestament to the hard work, perseverance and skill of
  15. 15. Capital Infusion: Private Equity Update 15all of those who were involved in pushing itsuccessfully across the finish line. “Only 14 dayspassed from the time we selected a lender to the timewe completed the investment,” said John Grafer, aPrincipal at Satori. “We appreciated the focus andintensity with which the Patton Boggs team worked tohelp us complete the investment before the holidays.”For a sample of other recently completed transactionsby the Private Equity Group of Patton Boggs LLP, seepage 24.TAX CONSEQUENCES:NONCOMPENSATORYPARTNERSHIP OPTIONSBy George Schutzer, Sean Clancy and Lindsay FainéThe Department of the Treasury and the InternalRevenue Service issued final regulations, effectiveFebruary 5, 2013, concerning the tax consequences ofnoncompensatory options and convertible instrumentsissued by a partnership or limited liability company,such as warrants. Among the various provisionscovered, the final regulations include a characterizationrule to determine whether a noncompensatory optionis treated as a direct interest in the issuing partnership.A key provision of the regulations implements a newtest to determine whether a noncompensatory warrantissued by a partnership or limited liability companytaxed as a partnership would be considered apartnership interest upon grant or other“measurement event.” If two conditions are satisfied,a noncompensatory warrant will be considered a directinterest for tax purposes. The first condition requiresthat “the noncompensatory option (and any agreementassociated with it) provides the option holder withrights that are substantially similar to the rightsafforded a partner.” A “penny” warrant, which is mostcommonly utilized as the typical “equity-kicker”received by a lender in a financing transaction, appearsto satisfy the first condition4, so the status of a penny4 The regulations state that a noncompensatory optionprovides the holder with rights substantially similar to apartner if (i) the option is reasonably certain to be exercisedor (ii) the option holder possesses partner attributes. Theregulations provide guidance for determining whether anoption is reasonably certain to be exercised. Under thatguidance, it appears that an option with a very low exerciseThese new regulations have very significantimportance to, among others, private investmentfunds that either are prohibited from receivingUnrelated Business Taxable Income (“UBTI”) or have astrong investor mandate or desire to limit exposure toany UBTI. These regulations will cause funds withforeign and tax-exempt investors to revisit theirprocedures for determining whether and how toacquire warrants in connection with loans to portfoliocompanies that are treated as partnerships for taxpurposes.
  16. 16. Capital Infusion: Private Equity Update 16warrant as a partnership interest is likely to depend onthe application of the second condition, whichrequires that:The new regulations state that the determination ofwhether the present value test is satisfied “is based onall of the facts and circumstances, including—→ “(i) The interaction of the allocations of theissuing partnership and the partners’ andnoncompensatory option holder’s Federal taxattributes (taking into account tax consequencesthat result from the interaction of the allocationswith the partners’ and noncompensatory optionholder’s Federal tax attributes that are unrelated tothe partnership);price will be considered reasonably certain to be exercised.A holder of a “penny” warrant might be able to argue incertain cases that, despite the apparent economics of thewarrant, it is not reasonably certain to be exercised becausethe holder is precluded by its own organizational documentsfrom holding an interest in a partnership or LLC operating abusiness and the only likely exit strategy is redemption orsale of the warrant. An analysis of that possible argument isbeyond the scope of this article.→ “(ii) the absolute amount of the Federal taxreduction;→ “(iii) the amount of the reduction relative tooverall tax liability; and→ “(iv) the timing of items of income anddeductions.”The regulations require that the analysis look throughpass-through entities such as partnerships, trusts,limited liability companies and S corporations that maybe partners. In many cases, the present value test willbe difficult to apply because the results depend on taxcharacteristics of partners of which the potentialwarrant holder may not be aware, assumptions aboutthe taxable income and losses, including amount andtype of income, of the partnership, and assumptionsabout the exit strategy of the warrant holder and of thepartnership. Nevertheless, we are providing somegeneral guidance below that may be helpful in trying toapply the test.→ Step 1: Determine whether the partnership islikely to generate tax losses for a period of timeand whether the losses will be significant. Theanalysis of the use of losses can be distinctlydifferent than the analysis of the use of income.→ Step 2: Determine what type of income thepartnership is likely to generate such as ordinaryincome, capital gains, and passive income that isnot included in unrelated business taxable incomeof tax-exempt investors (such as interest,dividends and royalties).→ Step 3: Assess the tax positions of the warrantholder or the partners/members of the warrantholder. Are they individuals, corporations,pension funds, governmental entities or tax-“There is a strong likelihood that the failure to treat theholder of the noncompensatory option as a partnerwould result in a substantial reduction in the presentvalue of the partners’ and noncompensatory optionholder’s aggregate Federal tax liabilities.” This articlefocuses on the application of the second condition,referred to in this article as “the present value test.”
  17. 17. Capital Infusion: Private Equity Update 17exempt entities? If the warrant holder is acorporation, does it have NOL carryovers that canabsorb income without any current taxconsequences (or relatively de minimis taxconsequences resulting from the alternativeminimum tax)?→ Step 4: Assess the tax positions of thepartners/members of the partnership.The following table points to factors that would leadto a favorable result (not satisfying the present valuetest) or an unfavorable result (satisfying the presentvalue test) for a penny warrant issued to a partnershipby a partnership that is expected to have taxableincome each year and for which there is no exitstrategy or expectation of a sale of the partnership orits assets in the short run.55 It is possible that if the warrant holder and partnership expect asale of the partnership or its assets in the short term, the taxconsequences of a potential sale need to be taken into account inthe analysis. The table below focuses primarily on taxconsequences from the operation of the partnership or LLC.
  18. 18. Capital Infusion: Private Equity Update 18INCOME PRODUCING PARTNERSHIPFAVORABLE FACTORS UNFAVORABLE FACTORSIssuingPartnership orLLCNone of, or only a small portion of, equityinterests in the issuing partnership or LLC heldby entities described in the box to the right.A substantial percentage of partnership interestsheld by:→ Corporations in full-tax position (no NOLcarryovers and taxed at a 34 percent or 35percent federal rate)→ Individuals who are taxed at the margin atthe highest individual marginal tax rates(unless partnership expected to generatesubstantial dividend or long-term capitalgains income).→ Foreign investors with effectively connectedincome.→ Partnerships with partners (or LLCs withmembers) described in the precedingbullets.A substantial portion of the equity interests inthe issuing partnership or LLC held by:→ Tax-exempt partners (unless (i) partnershipis engaged in a trade or business, (ii)partnership does not generate significantpassive income that is exempt from theunrelated business income tax, and (iii) tax-exempt partner does not have losses fromother unrelated business activity).→ Governmental entities (includinggovernment pension funds).→ Individual partners who are not taxed at themargin at the highest individual marginal taxrates.→ Corporations with NOL carryovers or thatare minimum-tax taxpayers.→ Individual partners if partnership isexpected to have significant capital gainand/or dividend income.→ Partnerships with partners (or LLCs withmembers) described in the precedingbullets.
  19. 19. Capital Infusion: Private Equity Update 19FAVORABLE FACTORS UNFAVORABLE FACTORSPartnership orLLC HoldingWarrantA substantial portion of the equity interests inthe warrant holder are held by:→ Tax-exempt partners (but only if (i) theissuing partnership is not engaged in anunrelated trade or business, (ii) the tax-exempt partners has substantial losses fromother unrelated trades or businesses, and/or(iii) the issuing partner is generatingsubstantial passive income that would beexempt from the unrelated business incometax).→ Governmental entities (includinggovernment pension funds).→ Individual partners who are not taxed at themargin at the highest individual marginal taxrates.→ Corporations with NOL carryovers or thatare minimum-tax taxpayers.→ Individual partners if holder is expected tohave significant capital gain and/or dividendincome.→ Partnerships with partners (or LLCs withmembers) described in the precedingbullets.Partners described in the first two bullets (andpartnerships with such partners) would be themost beneficial and would carry the greatestimpact when performing the analysis.None of, or only a small portion of, the equityinterests in the warrant holder held by entitiesdescribed in the first two bullets in the box tothe left.Substantial percentage of equity interests in thewarrant holder held by:→ Corporations in full-tax position (no NOLcarryovers and taxed at a 34 percent or 35-percent rate)→ Individuals who are taxed at the margin atthe highest individual marginal tax rates(unless partnership expected to generatesubstantial dividend or long-term capitalgains income).→ Foreign investors which would haveeffectively connected income if the warrantholder is treated as a partner of the issuingpartnership but would not have effectivelyconnected income if the warrant holder isnot treated as a partner.→ Tax-exempt entities that would be subjectto unrelated business income tax at a 34percent or 35-percent rate on their allocableshare of substantially all of the income ofthe issuing partnership if the warrant holderwere treated as a partner.→ Partnerships with partners (or LLCs withmembers) described in the precedingbullets.
  20. 20. Capital Infusion: Private Equity Update 20Note that the present value test requires a stronglikelihood of a substantial reduction in taxes if thewarrant holder is not treated as a partner.If the issuing partnership is expected to generate taxlosses for an extended period of time and the lossesmay have a greater present value than the incomegenerated by the issuing partnership before theexpected disposition of the business, the expectedredemption of the warrant, or another expected “exit,”many of the factors in the table above would flip, andthe following additional considerations would need tobe taken into account:→ Individuals, trusts and closely held corporationsare subject to the passive loss rules. Those rulesmay restrict or limit the ability of individuals,trusts and closely held corporations to use lossesfrom a trade or business conducted by thepartnership unless they have income from othersources or are actively involved in thepartnership’s trade or business. Therefore, itwould be helpful to have partners whose use oflosses is blocked by the passive loss rules in theissuing partnership and unhelpful to have them inthe warrant-holder partnership.→ Application of at-risk rules, basis rules, andpartnership allocation rules, which may operate tolimit the losses allocable to or usable by particularpartners of the issuing partnership and thewarrant-holder partnership.When undertaking an analysis of the present value test,one must also look at the rights that the warrantholder would have if it exercised the warrants. Forexample, if the warrant is for a class of partnershipinterest that only participates in distributions resultingfrom the sale of substantially all of the assets of theissuing partnership, one should not assume that if thewarrant holder were treated as a partner it would havea pro rata share of the all of the income of the issuingpartnership. Instead, it is more likely that it would onlyhave a pro rata share of the undistributed income ofthe partnership. This may be material in determiningwhether the failure to treat the warrant holder as apartner results in a substantial reduction in tax liability.This article provides only a flavor of factors that maybe taken into account when assessing whether awarrant is likely to pass or fail the present value test.Other factors may also play a role in determiningwhether a particular warrant will pass or fail the test.For example, it may be necessary to compare the taxconsequences of a potential exit strategy. Each pennywarrant must be examined separately, but an overallevaluation of the composition of a warrant holder-partnership may provide a good indicator of whetherits warrants can generally be expected to pass or failthe test. The factors provided in the table above areintended to provide general guidance but should notTherefore, if as a whole the partners of the warrantholder would bear about the same tax liability withrespect to an allocable portion of the income of theissuing partnership as the partners of the issuingpartnership would bear if the income was allocated tothem rather than the warrant holder, the present valuetest is not likely to be satisfied and the warrant holderwould not have to be treated as a partner.
  21. 21. Capital Infusion: Private Equity Update 21be strictly relied upon when making a determination asto whether a warrant would be classified as apartnership interest for federal income tax purposes.Rather, we recommend that persons making thisdetermination consult with their tax and legal advisorsto ensure that all the facts and circumstances relatingto the warrant ownership and the issuing partnershipcan be fully considered. The tax and finance team atPatton Boggs is available to assist warrant holders andpotential warrant holders in undertaking an analysis ofwhether a warrant will be considered a partnershipinterest.To ensure compliance with requirements imposed by the IRS, weinform you that any tax advice contained in this communication(including attachments) is not intended or written to be used,and cannot be used, for the purpose of (i) avoiding penaltiesunder the Internal Revenue Code or (ii) promoting, marketing,or recommending to another party any transaction or matteraddressed herein.A NEW DAY FOR PATENTSBy Robert Johnston IIIAs of March 16, 2013, all the provisions of the Leahy-Smith American Invents Act (“AIA”) have becomeeffective. The AIA creates a new patent system for theUnited States with important ramifications for alltechnology companies.THE UNITED STATES IS NOW UNDER A FIRST-INVENTOR-TO-FILE SYSTEMBefore the change, the American patent system was afirst-inventor-to-invent system. Under this old system,in a competition between independent inventors, thefirst individual or individuals to invent were generallyawarded the patent. Thus, individuals who were firstto invent but second to file at the United States Patentand Trademark Office (“USPTO”) were able—potentially—to receive the patent. No more.The first-inventor-to-file system applies to U.S. patentapplications that contain, or contained at any time, atleast one claim having an effective filing date on orafter March 16, 2013. Furthermore, unlike under thefirst-inventor-to-invent system, inventors under thefirst-inventor-to-file system are not able to use theinvention date to avoid prior art that appears betweenthe invention date and filing date.A LARGER UNIVERSE OF PRIOR ARTThe universe of prior art available for comparison tothe invention has increased significantly as of March16. This may make it more difficult to obtain a patent.Under the old law, an inventor had one year fromwhen the invention appeared in a publication or wasused or sold (each constituting prior art) to file apatent application. This one-year period was known asa “grace period.” Under the new provisions, theblanket one-year grace period is gone. Any prior artavailable before the filing date is now available toapply against the patent application with oneimportant exception. The exception provides that ifUnder the AIA’s new first-inventor-to-file system, thefirst inventor to file a patent application in the UnitedStates will be awarded the patent. This is amomentous shift from the first-inventor-to-inventsystem.
  22. 22. Capital Infusion: Private Equity Update 22the invention was directly or indirectly disclosedwithin one year of the filing date by the inventor, theinventor will not be blocked by prior art appearingbetween the disclosure and the filing date. The exactscope of this exception is ill-defined and should not berelied upon until the courts interpret it.The AIA also expands the universe of prior art byeliminating what was called the Hilmer Doctrine.Under the long-standing Hilmer Doctrine, onlypublished U.S. applications and internationalapplications that designated the United States asrecipient were available for use as prior art as of theirinitial filing date. Now, published patent applicationsand patents—regardless of where filed or in whatlanguage they are filed—are available as prior arteffective as of their initial filing date.The AIA has also removed geographical limitationsthat existed for certain prior art. Under the old law,public use and sales activities could not be used asprior art if the activities occurred outside the UnitedStates. Now, the relevant provision has nogeographical restriction.POST-GRANT REVIEWSometime after March 16t, we will see the new PostGrant Review (“PGR”) process used to challenge thevalidity of issued patents upon any grounds ofpatentability (novelty, obviousness, lack ofenablement, etc.). The PGR provides a mechanism forchallenging the validity of patents at the USPTOinstead of the federal courthouse. To use a PGR, thepetitioner must show that it is “more likely than notthat at least one of the claims challenged isunpatentable.” Moreover, a PGR must be initiatedwithin nine months of a patent grant and is onlyapplicable to patents issued under the new first-inventor-to-file system. Because of this latterrequirement, we will most likely not see a PGR for atleast one or two years.RECOMMENDATIONSYou should also consider monitoring patents issued toyour competitors and evaluating opportunities underthe PGR proceedings to challenge a competitor’sintellectual property before it can create problems foryou in the marketplace. A timely filed PGR may helpyou to avoid high-cost litigation down the road.EVENT SPOTLIGHT: HEALTHCARE SEMINAROn April 25, Patton Boggs presented a seminarconsisting of two panels addressing importantemerging topics in health care that impact business.The seminar consisted of two panels, one coveringimplementation of the Affordable Care Act (“ACA”)and the other covering trends in health careinvestigations and enforcement activities. FormerSenator and Senior Counsel John Breaux kicked offthe event by discussing the political climate for healthcare issues and health care companies. The first panelUnder the new law, you should file as soon as possibleafter creating a new invention. Filing processes shouldbe reviewed and streamlined. Furthermore, you shoulddiscuss the filing timeline with your attorney on eachpatent application.
  23. 23. Capital Infusion: Private Equity Update 23covered topics including Medicaid expansion, healthinsurance exchanges, new taxes and fees that originatein the ACA, the essential health benefits package, andother issues that impact employers. The second panelcovered the increased scrutiny on health carecompanies, the importance of a robust complianceprogram, trends in congressional investigations, andtrends in civil and criminal enforcement activity inhealth care. For audio of the full seminar, please clickhere
  24. 24. Capital Infusion: Private Equity Update 24PATTON BOGGS DEALSOur expertise and experience in private equity investment activities puts us in the middle of transactions ranging fromearly stage investing to acquisitions and dispositions of investment targets, and the financing of such investments. Thefollowing is a selection of our recent transactions.LIVINGSTON INTERNATIONAL INC. SWK HOLDINGS CORPORATIONORIX MEZZANINE & PRIVATEEQUITY INVESTMENTSAcquisition of Norman G. Jensen,Inc. (“NGJ”), including its Canadianbrokerage company, JensenCustoms Brokers Canada (“JCBC”).NGJ is a major independentcustoms broker headquartered inMinneapolis, Minnesota whichspecializes in providing import andexport services to high-volumecommodity shippers.Acquisition by SWK HoldingsCorporation of InSite VisionIncorporated’s royalty on future salesof Besivance® to SWK FundingLLC, a wholly-owned subsidiary ofSWK Holdings Corporation and BessRoyalty, L.P. for up to $16 million.Besivance (besifloxacin ophthalmicsuspension) 0.6% is marketedglobally by Bausch + Lomb for thetreatment of bacterial conjunctivitis.Mezzanine and private equityinvestment for the acquisition ofSierra Engineering and SierraPetroleum Services, Ltd. byCorinthian Capital Group, LLC andits management. Sierra providesengineering and consulting servicesto the oil and gas industry.Confidential Up to $16,000,000 ConfidentialAMERICAN CAPITAL, LTD. PENINSULA CAPITAL PARTNERSZERO EMISSION ENERGY PLANTSLTD.Acquisition of Cambridge MajorLaboratories, Inc., a leading globalprovider of complex chemistry-based outsourcing services to thepharmaceutical and biotechnologyindustries.Mezzanine and private equityinvestment to support a leveragedbuyout by The LIT Group, L.L.C.The LIT Group provides nationwidedeposition and litigation supportservices to law firms, Fortune 500companies and regulatory agencies.Formation of joint venture withTodd Corporation to construct amethanol production facility inLouisiana that will convert naturalgas into 5,000 metric tons per dayof methanol and will be the largestmethanol production facility inNorth America when completed.$212,000,000 Confidential Confidential
  25. 25. Capital Infusion: Private Equity Update 25ORIX PRIVATE EQUITYTHE MEADOWS, A PORTFOLIOCOMPANY OF AMERICAN CAPITAL,LTD.SATORI CAPITALInvestment in R2integrated, aleading digital and social marketingagency.Acquisition of Remuda Ranch, aninpatient and residential center forwomen, adolescents and childrensuffering from eating disorders andrelated issues.Acquisition of Austin basedLonghorn Health Solutions Inc. , adirect-to-home provider ofconsumable medical supplies,durable medical equipment, andpharmaceutical prescriptions.Confidential Confidential ConfidentialFIRST PLACE FINANCIAL CORP. PACIFIC PREMIER BANCORP, INC. SEACOAST CAPITALSale of substantially all of its assets,including all of the outstandingshares of its wholly owned banksubsidiary, to Talmer Bancorp, Inc.pursuant to Section 363 of the U.S.Bankruptcy Code.Acquisition of First AssociationsBank, a Texas-chartered specialtybank focused on home owners’association management services.Private equity investment inNorthwest Cascade, Inc., a providerof diversified commercial, industrialand residential services, andconstruction of municipal sewerageand commercial and residentialwastewater infrastructure.Confidential $56,700,000 ConfidentialAMERICAN CAPITAL ALCHEMY SYSTEMS, LP PENINSULA CAPITAL PARTNERSAcquisition of ASAP Industries, aleading independent manufacturerand refurbisher of high-pressureflow control products for the globaloil and gas industry.Disposition of Alchemy Systems(Alchemy) of Austin, Texas, aprovider of food and workplacesafety training solutions deliveredthrough a software-as-a-service(SaaS) model, to The RiversideCompany.Subordinated debt and privateequity investment to facilitate theacquisition of Whitewater Brands,in partnership with Rock GatePartners, LLC.$89,000,000 $56,700,000 Confidential
  26. 26. Capital Infusion: Private Equity Update 26For more information, contact your Patton Boggs LLP attorney, the author of the included articles, or any ofthe editors listed below.DAVID MCLEAN214-758-3553dmclean@pattonboggs.comJON FINGER214-758-6697jfinger@pattonboggs.comADAM CONNATSER214-758-1579aconnatser@pattonboggs.comATWOOD JETER214-758-3597ajeter@pattonboggs.comRANI GUERRA214-758-3427rguerra@pattonboggs.comABU DHABIMarina Office Park Villa A23P.O. Box 31808Abu Dhabi, United Arab EmiratesP: +971-2-651-5900ANCHORAGE601 West Fifth Avenue, Suite 700Anchorage, Alaska 99501P: 907-263-6300DALLAS2000 McKinney Ave, Suite 1700Dallas, Texas 75201P: 214-758-1500DENVER1801 California Street, Suite 4900Denver, Colorado 80202P: 303-830-1776DOHAThe Commercial Bank Plaza (CBQ),16th Floor , Dafna AreaP.O. Box 22632Doha, QatarP: +974-4-453-2500DUBAIThe Gate, Dubai InternationalFinancial CentreP.O. Box 121208Dubai, United Arab EmiratesP: +971-4-401-9738NEW JERSEYOne Riverfront Plaza1037 Raymond Blvd., Suite 600Newark, New Jersey 07102P: 973-848-5600NEW YORK1185 Avenue of the Americas(between 46th and 47th Streets)30th FloorNew York, New York 10036P: 646-557-5100RIYADHKing Fahad RoadSky Towers - 8th FloorRiyadh, Saudi Arabia 11372P: +966-1-416-9990WASHINGTON DC2550 M Street, NWWashington, DC 20037P: 202-457-6000